Bankruptcy is a scary word — it drums up horror stories of business giants tumbling from grace or gossip magazine headlines shaming celebrities for mismanaging their funds. But declaring bankruptcy doesn’t mean you are a failure or deserving of ridicule. Bankruptcy is simply when you owe more than you can afford to pay and it’s very common — in 2012, over 1.2 million Americans filed for bankruptcy, according to estimates from Epiq Systems.
The two most common types of consumer bankruptcy are Chapter 7 and Chapter 13. Chapter 7 bankruptcy liquidates all your non-exempt assets to pay off creditors. It can be a good choice if you have large amounts of unsecured debt, like credit card debt. Chapter 13 bankruptcy reorganizes your debts and puts you on a payment plan, and can be a good option if you want to hold onto certain non-exempt assets or avoid foreclosure on your home.
In many ways, filing for bankruptcy can be viewed as a business decision — and in the business of life, sometimes you get into tough financial situations. Declaring bankruptcy can eliminate certain debts, free up funds and help you get a fresh start, but that doesn’t mean you should run off and file when you get in a financial bind — the consequences of declaring bankruptcy can be felt for years. It’s a serious decision that shouldn’t be taken lightly.
So how do you know when it’s time to file? Here are five circumstances when declaring bankruptcy makes sense.
1. You Are a Senior Citizen With No Income and a Lot of Debt
More and more senior citizens are filing for bankruptcy due to decreasing pensions and the rising cost of health care. A 2010 report by John Pottow, a Michigan Law School Professor, found that seniors are the fastest-growing group of bankruptcy filers. Filing for bankruptcy can make sense for many seniors, especially since they usually live on a fixed income and don’t work.
Still, senior citizens must pass a bankruptcy test to qualify, which compares your average monthly income against the state median. If your income is too high, due to your pension or other income, you could be ineligible. Luckily, any Social Security benefits you receive don’t count as income and almost all tax exempt accounts, like 401(k)s, 403(b)s, profit-sharing, money purchase and defined-benefit plans, are exempt in bankruptcy.
IRAs and Roth IRAs are also protected up to $1,245,475 (this number is adjusted every three years — it was last set in 2013). To be on the safe side, seniors looking to file bankruptcy should keep their Social Security money in a separate account and let creditors know in writing that the funds in that account are all from Social Security.
Since many senior citizens count on their home equity to fund their retirement, they need to make sure that’s also protected under bankruptcy law. Many states, as well as federal bankruptcy exemptions, offer people filing bankruptcy a homestead exemption to protect a portion of their home equity, and some states even have higher exemptions just for senior citizens. Check your state’s homestead exemption laws before considering filing for bankruptcy.
2. You Can’t Pay Your Medical Bills
According to a study by NerdWallet Health, unpaid medical bills are expected to surpass credit card and mortgage debt as the leading cause of bankruptcy filings. Medical debt doesn’t only affect the uninsured — one expert estimated 78 percent of people that file for bankruptcy due to medical bills had health insurance. according to Fox Business.
Co-pays, special treatments, co-insurance and time off work contribute to the costs of medical care and can easily push someone with health insurance into debt. For the uninsured, a minor medical procedure or simply paying for prescriptions out of pocket can rack up huge amounts of medical debt, too.
Filing for bankruptcy can eliminate all your medical bills, but only old debts will be discharged. If you incur more medical debt after filing, you will still owe on the new debt. Make sure all your medical bills and debts are accounted for before filing — and if you know you’re going to rack up more medical bills, consider waiting to file so you can include all your debts.
3. You Are Drowning in Credit Card Debt
If you can only make minimum payments on your credit cards and are using credit to pay for basic necessities, it might be time to declare bankruptcy. Before making the decision, take inventory of all your assets: bank accounts, retirement funds, investments, real estate, cars and anything else of significant value. Then add up all your debts. If your debts are more than the value of your assets, declaring bankruptcy might be the right choice.
Before you file, a word of warning: Don’t run out and spend with wild abandon before you declare bankruptcy. Charging up your credit cards right before filing can be ruled as fraud by the courts and that debt won’t be discharged.
4. Your Ex Just Declared Bankruptcy — and You Can’t Pay the Debt
Getting divorced can be financially devastating — you can be left with massive legal fees, unpaid bills and a lot of debt. If you leave your marriage with debt that is only in your name, filing for bankruptcy can offer some much-needed relief, but things aren’t always so cut and dry: If the debt is in both your and your ex-spouse’s name, you might both need to declare bankruptcy.
If you have debt in both your names and your ex-spouse declares bankruptcy, creditors can still collect from you. Even if the divorce settlement states your ex is responsible for the debt and he declares bankruptcy, the debt cannot be discharged and the creditor can still come after you for payment. It’s important to understand that the divorce settlement doesn’t remove anyone’s personal responsibility to pay; it only forces the other spouse to pay the debt.
Filing joint bankruptcy will eliminate everyone’s responsibility to pay, which is why it sometimes makes sense for both spouses to declare bankruptcy and discharge all joint debts.
5. You Are Unemployed and Deep in Debt
If you have been unemployed for an extended period of time and have no financial resources to fall back on, declaring bankruptcy can help keep you afloat until you find a new job. This decision should be weighed carefully, though; some employers conduct credit screenings as part of a background check and bankruptcy is so damaging to your credit, it could hurt your chances of landing a job.
Still, being unemployed can make the process easier, because your income is probably close to or below the median income requirement in your state for Chapter 7 bankruptcy. If you don’t qualify for Chapter 7, you can look into filing Chapter 13 bankruptcy, but since you are unemployed, it’s possible you can’t afford the repayment plan and the court will dismiss your case.
Photo credit: Michael Coghlan